Exonerating the Community Reinvestment Act (from causing the crisis anyway)

Steven Horwitz

In my various talks and written work on the financial crisis and the recession, I've taken pains to minimize the responsibility assigned to the Community Reinvestment Act for causing the high-risk loans that led to so much trouble. This point often bothers many free market types in the audience/readership who are convinced the CRA was a major cause of the high risk loans that were the core of the problem. I have responded by saying that what I knew of the empirical evidence showed that the CRA was a minor factor, if one at all. Today, I came across a piece that really makes that case clearly and points to the relevant empirics.

Dwight Jaffee of the Berkeley Business School testified in front of a Congressional Commission on the crisis and the written version of his remarks are linked here (Note: it's on Scribd and can only be printed off the web, not downloaded). Those remarks are one of the best overviews of the role of housing policy and the various agencies that I've read since the recession began. I recommend it highly. He puts the blame squarely on Fannie and Freddie and the way in which they combined private profits with a public mission and an implicit government guarantee.

But he also exonerates the CRA. Based on a Fed study by Canner and Bhuta (2008) (and a similar study by Traiger and Hinckley in 2008 that reached similar results) that compared default rates and the like between zip codes that just qualified for CRA credit and those that did not, Jaffee reports:

Only 6 percent of identified subprime mortgages in 2006 were made to CRA-qualified borrowers or neighborhoods by CRA-covered institutions.

For loans originated between January 2004 and April 2008, the observed 90-day delinquency rates are actually slightly lower in zip codes that are CRA-qualified than for zip codes with median incomes that are just sufficiently higher to make them CRA-unqualified.

The reason why the CRA wasn't a factor is two-fold: it does not cover non-bank lenders, such as mortgage and finance companies, which means all the high-risk loans originated from those sources (which were many) were taking place without CRA incentives. They were much more about being able to sell them off to Fannie and Freddie. Second, in theory, the banks to whom the CRA does apply still had to demonstrate their loans were "within the norms of safe and sound operation."

As Jaffee says, there may be lots of other reasons to not like the CRA, but that list should not include any responsibility for the financial crisis. So folks, it's time to stop blaming the crisis on the CRA and get the attention back where it belongs: expansionary monetary policy combined with GSEs with a government guarantee.

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Steve, this is NOT the argument for the role of CRA in the boom / bust.

The argument is that the CRA pushed / encouraged companies to change their lending practices and corporate culture in order to qualify for expanding their company by purchasing other banks and lenders.

Steve Sailer on his blog has the documents and the basic outlines of the story.

BofA, WaMU and Countrywide are key players.

Also.

I don't trust you economists when it comes to what happened on the ground -- case studies offer far more information on what actually happened, say in Santa Anna, CA than what you get from the econometric data miners.

It's one of the modern pathologies of the culture of fake science that practically zero economists do field research, say, like they do in the science of biology.

In practice, as documented in the Orange County Register and elsewhere, this is laughable:

"in theory, the banks to whom the CRA does apply still had to demonstrate their loans were "within the norms of safe and sound operation."

WaMU gave loans on the basis of a picture of a mariachi standing in front of a house -- a true story. The OC Register has interviews with the very people involved in the transactions.

Just for the record, I believe Fannie and Freddie _were_ more important than the CRA .. it's a multiple causation story. But the CRA and its relation to WaMU and Countrywide and BofA certainly is part of that wider causal story of an industry that lost all lending standards.

It is important to distinguish between CRA requirements and subprime loans. I read the OCR article as being about the latter. Subprime loans could be used to meet CRA requirements, but that just shows how banks game such requirements.

Subprime loans appeared to be profitable and that is why banks and nonbanks alike piled into them. The underlying principle was the greater-fool theory. The necessary condition for the apparent profitability of such loans was the Fed's low interest-rate policy.

It is important to understand that many of the lapses in housing lending repeated past episodes. Not only suprime loans, but also Alt-A loans often required low documentation or no documentation of income and assets. So-called low-doc and no-doc lending had been tried at least twice before by banks. It almost brought down Citi's consumer bank twice. The underlying principle is "this time is different."

Jerry -- lots of people in the finance industry knew bad loans were being made. Some of it, as on my little street, was intentional fraud, paying people who planned to default to sign their name to mortgage origination papers, which were then resold.

We had prostitutes living on our street, participating in this fraud. The FBI massively cut the budget and manpower for going after mortgage fraud in the early 2000s (there's an LA Times story on it).

Field studies are useful, but one must also beware of small sample bias. That Orange County was the fountainhead and epicenter of the sub-prime loan industry is precisely why it may not be a representative source of data on this matter for the country at large.

As for Sailer's numbers, the caveats enunciated by Steve still hold. Maybe CRA played some role, but it was far less than Fannie or Freddie, and the people who run around saying that it was CRA, CRA, CRA, over and over, are chickens with their heads cut off. Many of those people seem to have an agenda that I shall not describe further here.

In response to your attempt to win by volume (in both senses of the term), here's some "on the ground" information for you. My former college roommate has been in the *thick* of the mortgage business for over 20 years. He worked for a local mortgage company, he worked at Fannie Mae in the late 90s and early 00s, and he worked at Countrywide until around 05 or 06. Trust me when I tell you he knows the business *extremely* well. (I'd argue HE bears more blame than the CRA as he developed some of the zero down payment instruments while at Fannie! That was a joke if he's reading...)

Here's his reaction to Jaffee's paper: "Yes - Jaffee nails it!" He has been telling me from day one that the CRA was a minor player at most. I was skeptical at first, but I've been convinced by the empirical evidence.

And as Jerry says "subprime" does not equal "CRA." Yes, subprime loans could count toward the CRA *but only if you were a bank covered by it!!* It was irrelevant for mortgage and finance companies. No one is doubting the role played by subprimes and fraud on all sides. What I'm saying is that this is separate from the CRA no matter how much you stamp your feet and want it to be true.

I simply do not see what good it does the bigger picture argument that you and I largely agree on to insist that the CRA is to blame when the evidence strongly suggests otherwise. I'm not playing armchair economist here - what Jaffee says is consistent with what my VERY reliable and very knowledgeable "on the ground" source tells me.

If we want to avoid sounding like the ideologues that Barkley is hinting at, we better worry first about the facts. I'm quite confident the facts bear out the story we have been telling, but no one's gonna listen if we keep making shit up.

I dislike myopic econometric studies as much as anyone, but I have to agree as well that the data doesn't square well with placing the blame on the CRA. I think it's fair an accurate to say that we can know a priori that something like the CRA will create bad incentives and screw things up, but the question is HOW MUCH those effects contributed. If the CRA only explains about one percent or less of the crisis, those incentives aren't one of "the" causes we should be looking at. This doesn't contradict the existence of those field studies (or perhaps more accurately, anecdotal evidence) which Greg Ransom posts, since there is no reason to believe those anecdotes don't fall in that one percent.

The way the numbers play out, I think it's accurate to say that blaming the CRA is like blaming a two percent tariff for a two hundred percent increase in prices.

"Your hysterical reaction suggests you think it's far closer to "CRA CRA CRA!" than to where I am."

I'm with this guy:

Jerry writes:

"Someone close to the issue told me he wouldn't put CRA among the top 5 factors (Fan & Fred are in that group), but he would put it in the top 10."

CRA was part of the trashing of lending standards, and part of the artificial spike to housing demand in some regional markets.

I said "part".

The evidence and actual causal narrative is hard to get at -- both on the statistical side and on the "field research" or journalism side.

The stuff Sailer points to is not widely known at all.

Sorry for seeming to have a fit -- I really simply wanted to highlight the fact that key elements of the CRA story are not capture using the aggregated statistical relations the economist you cite are using. There is no direct ethnic data, there is no focus on communities where CRA operation where emphasized, there is no look at what actually took place within firms and on the ground, etc (as you report these studies, I haven't read them).

Jerry's comment hadn't cleared before I sent mine, and I can live with his friend's framing of it. I'd put the CRA toward the bottom of the top 10 in any case.

If that's so, why the over-reaction? I started my post by saying I'd been arguing all along it was a "minor factor" at most, and lord knows I'm not guilty of single-causal theories on this issue. The vehemence of your reaction was right in line with the character Barkley was talking about. I hope you can undertand why I would react with equal vehmence back.

Steve, I'm an over determination guy, a complex causal narrative guy. I'm not a "blame one single thing" guy.

What I want is a true and full story of what role the CRA did play in the pathologies of the 2000s -- and all the other many, many elements of the story as well.

How do we get that?

I say it won't be easy, and it won't simply come from econometricians using a national statistical focus and without access to ethnic numbers. The housing boom and bust is mostly a regional story. The CRA is in part an ethnic story. It's also a corporate culture story and a political story. Statistical data mining on a national data sample lacking ethnic data is not going to get you much of the story.

Steve writes:

"I simply do not see what good it does the bigger picture argument that you and I largely agree on to insist that the CRA is to blame when the evidence strongly suggests otherwise."

Note that I was referring to the people crying "CRA, CRA, CRA!" which nobody here seems to support at all, including Greg apparently. I most definitely did not say that my hints applied to someone who said that it might play "some" role (and I'm willing to throw it into the large pot of things that played roles).

As it is, Sailer is known to have certain obsessions, but will comment no further on that here on this thread.

Wow. Jaffe is completely clueless about the real arguments regarding CRA's role in the housing meltdown.

Jaffe obviously hasn't read any of the work of Ed Pinto, the former risk officer at Fannie, who has pointed out that the kind of stats that Jaffe cites on CRA lending wildly understate the real number of these loans that were subprime because banks "commonly classified CRA loans as “subprime” only if they contained such features as high fees, high rates, or low initial payments with adjustable interest rates. But approximately 50 percent of CRA loans for single-family residences were nevertheless made to borrowers who made down payments of 5 percent or less or had low credit scores—characteristics that indicated high credit risk. Whether or not anyone called these loans “subprime,” in other words, the chances are good that many of them have defaulted or remain at high risk of doing so."

And trying to separate Fannie and Freddie from CRA misses much of what was going on. The GSEs didn't just independently decide to start buying up subprime mortgages. They were pushed into it starting in the early 1990s when banks rightfully complained that they could only make so many CRA loans because there was no one there to buy up these debt and clear it off their books.

That led to pressure from HUD during the Clinton admin. on Fannie and Freddie, and it extended well beyond banks that were subject to CRA. Reps. like Maxine Waters started bashing the non-bank lenders, and HUD threatened to extend CRA to them if they didn't start make CRA-type loans.

Fannie and Freddie crafted numerous lending programs with these non-bank lenders after they GSE's agreed to up their buying of so-called affordable mortgages. One of the first deals was between Fannie and Countrywide, which was not heavily into this market at the time. Fannie and Freddie originally agreed to buy these things not to generate new profits but to protect their other profitable business from more congressional intervention.

Be clear that Freddie oversite and policy was not untied to CRA policy and goal as Barney Frank openly told us -- Clinton and his Freddie team and the Congress pursued a combined Freddie / CRA policy with declining standards as a package deal.

Also, the business strategy of WaMu was a takeover and expand strategy which required making the Feds happy acvording to the CRA agenda -- the corporate culture of declining lending standard at WaMu came to defies belief.

I overreacted because the same sort of aggregated data with no context argument has been used to say that Freddie played no role, and because ther is a core problem with using stats that can't reach the local and disaggregated phenomena or the corporate culture / strategy or political / economic strategy which changed culture and behavior and standards and expectations.

2. I have made the point repeatedly that housing policy in genereal, including policy designed to expanding homeownership to lower income groups via mandates to Fannie and Freddie, was, after the Fed, the key factor here. But that is not the CRA specificaly.

If you want to blame "housing policy designed to increase home ownership among lower income groups," I'm right there with you. But that is not necessarily about the CRA *specifically*.

One of the biggest voice out there -- Mark Levin -- always talks about this as a package deal / Freddie / CRA policy to degrade finance to put people in homes who can't pay for them -- he always mentions Raines' efforts at Freddie and he repeatedly plays audio of Barney Frank talking about this general policy goal and using Freddie and CRA to push it.

I've heard Rush and Hannity say similar things.

I'd wager that the "CRA did it" thing is either a shorthand for a few or a dated talking point some folks grabbed hold of early on and still clutch.

This may include many dim witted pols.

Steve writes:

"I have made the point repeatedly that housing policy in genereal, including policy designed to expanding homeownership to lower income groups via mandates to Fannie and Freddie, was, after the Fed, the key factor here. But that is not the CRA specificaly.

If you want to blame "housing policy designed to increase home ownership among lower income groups," I'm right there with you. But that is not necessarily about the CRA."

"Richard Syron, .. was head of the Boston Fed when it 'proved' that existing residential lending was discriminatory and too conservative back in 1992, and was rewarded as head of Fannie Mae, where he pocketed $38MM for running it into the ground."

That's from one of the dozens of articles I collected in Jan. of 2009 on "what caused the boom / bust":

A stimulating discussion...I tend to be with Greg Ransom on this one. I think CRA (among other programs) helped to create a different, "anything goes if it makes money" culture that is probably impossible to discern "in the data." But it's painfully evident in the anecdotal evidence from the field (how many anecdotes does it take to make something statistically significant?). Bad policy is corrosive...and the acid tends to burn away the evidence.

"Yet even by WaMu’s relaxed standards, one mortgage four years ago raised eyebrows. The borrower was claiming a six-figure income and an unusual profession: mariachi singer.

Mr. Parsons could not verify the singer’s income, so he had him photographed in front of his home dressed in his mariachi outfit. The photo went into a WaMu file. Approved.

“I’d lie if I said every piece of documentation was properly signed and dated,” said Mr. Parsons, speaking through wire-reinforced glass at a California prison near here, where he is serving 16 months for theft after his fourth arrest — all involving drugs.

While Mr. Parsons, whose incarceration is not related to his work for WaMu, oversaw a team screening mortgage applications, he was snorting methamphetamine daily, he said.

“In our world, it was tolerated,” said Sherri Zaback, who worked for Mr. Parsons ... "

I live in Ireland, four years ago I lived in Britain. I come from Britain.

In these countries there is *NO*:
* Fannie & Freddie, or equivalents.
* CRA or redlining or positive discrimination.
* Encouragement of 30 year fixed rate mortgages.

And,
* There is little securitization of mortgages. (Almost none in Ireland, <10% in Britain).
* ARMs are standard here. Fixed rate mortgages only arrived in the last few years.
* Teaser rate mortgages have been around for years.

But, the housing markets here crashed in 2007 before they did in the US.

I think that everyone underplays the big player here, and the big player is the Fed.

"Ireland had none of the American right’s favorite villains: there was no Community Reinvestment Act, no Fannie Mae or Freddie Mac."

Obviously I'd go along with cheap credit being the common denominator, but Constantin Gurdgiev points out:

"The squeeze on the property market was complete - the supply was artificially restricted, demand was artificially inflated and the Government was actively 'talking the market up'. The banks were encouraged to lend and the regulators were directly selected to be complacent, inactive and on some occasions - outright unsuited to run the complex world of finance."

Jerry: "in that Britain has no deductability of mortgage interest payments."

That's true, but "offset mortgages" were introduced recently. They allow an amount of savings to offset a mortgage debt. So, they allow some saving of tax.

Anthony Evans,

To some extent I agree. In Britain planning laws have long being used to make housing artificially scarce. But, I'm not sure that is significant stimulus to the market.

Something I think is important in Ireland is the difference in the law surrounding housing compared to continental Europe. France has laws against housing speculation. If you buy a house and sell it within 5 years you must sell no higher price than you bought it for. I don't know if Germany has the same laws though.

The stimulating effect of low interest rates fell on the economies that have the least regulation around creating physical capital such as buildings. Spain and Ireland are similar in that regard.

During the last decade when housing prices were roaring in Ireland, Spain, and some other countries more than even in the US, they were falling in Germany as well as Japan. I gave a talk five years ago in Germany about speculative bubbles and mentioned the one in the US, and one German prof in the audience commented that "we would sort of like to have at least a bit of a bubble here." Of course right now, they are not looking so bad in all this.

In the US Texas did not bubble, which looks like a combo of few supply restrictions with stricter rules on mortgage lending than other states, probably a legacy of the commercial real estate bubble in the 1980s that led to the S&L crisis.

Look at actual firms and flesh and blood people, and chart their actions in real places. E.g. let's look at where WaMu and Countrywide were expanding their "Walmart" operations, and where they weren't. Let's see, that would be California and Florida and Arizona ...

Here's an account of what WaMu was up to:

"Killinger's goal was to build WaMu into the “Wal-Mart of Banking,” which would cater to lower- and middle-class consumers that other banks deemed too risky. Complex mortgages and credit cards had terms that made it easy for the least creditworthy borrowers to get financing, a strategy the bank extended in big cities, including Chicago, New York and Los Angeles. WaMu pressed sales agents to approve loans while placing less emphasis on borrowers’ incomes and assets. WaMu set up a system that enabled real estate agents to collect fees of more than $10,000 for bringing in borrowers. Variable-rate loans — Option Adjustable Rate Mortgages (Option ARMs) in particular — were especially attractive because they carried higher fees than other loans, and allowed WaMu to book profits on interest payments that borrowers deferred. As WaMu was selling many of its loans to investors, it worried less about defaults."

In Germany's case, the "pfandbrief" is the dominant mortgage financing instrument. These are covered bonds, a bit like mortgage-backed securities.

Anyways, German law limits the sorts of mortgage loans that can be packaged into pfandbrief to loan-to-value ratios of 60%. Compare this to the 100% LTVs often seen in the US. All assets packaged into pfandbrief must stay on the issuers balance sheet. I think that's why the housing bubble skipped Germany.

Switzerland has the same tradition, it also avoided the housing bubble.

Part of what I'm saying is that the Boettke/Horwitz model of how to understand what happened after Katrina should be used by economists to understand what happened in California, Florida and Arizona ... and in D.C. and on Wall Street.

Economic understanding is a force multiplier when it comes to narrative in the case of Katrina -- and in the case of housing/ economy boom and bust.

Russ Roberts work on moral hazard + Michael Lewis detailed history would be at least 4 times better than what each of them has produced without the aid of what the other one brings to the table.

Canner and Bhutta: “The CRA does not cover non-bank lenders, such as mortgage and finance companies, so their active participation in subprime lending occurred without any CRA incentives.”

I think this is wrong. The CRA gave non-bank lenders every reason to engage in sub-prime lending.

This is a bit labyrinthine ...

To meet CRA requirements, a depository might originate its own CRA loans. Even easier, it need only hold MBS backed by CRA-eligible loans. How might it get its hands on these MBS? They were sold to the depository by Fannie Mae as a specially “targeted MBS”. And how did Fannie get these CRA-eligible loans? They bought them on spec from all sorts of lenders who participated in the Fannie MyCommunity mortgage program. Many of these participating lenders were not covered by CRA and therefore didn’t need to originate CRA mortgages, but nevertheless the system of incentives encouraged them to make CRA loans and sell them off to those who needed them. After all, CRA loans were priced at a premium to normal loans. Fannie stood in the middle turning poor credit into fully liquid and guaranteed securities.

Fannie/Freddie and CRA are incestuously interwined, hard to let one off the hook without letting off the other. I don't think that Jaffee et al have done all their homework here since neither of them mention CRA-eligible MBS created via F&F.

Economists could discover much about what happened in the complete population of foreclosures in a region -- if the profession gave status and money to economists who did such research.

Think of the 10s of thousands of economists essentially on the public dime -- and consider that none of them see it as professionally or financially in their interest to do field work in this area at the center of the most significant economic event of our time.

> Anyways, German law limits the sorts of mortgage loans
> that can be packaged into pfandbrief to loan-to-value
> ratios of 60%.

Again, by comparison with Britain I'm a little sceptical. AFAIK historically loan-to-value ratios in Britain were 70-80%. During the housing boom there were some 100% mortgages too. But, I know when I was shopping for a mortgage that what most banks and building societies were selling was 70-80% loan-to-value mortgages.

The real estate market is too big (it includes commercial and residential real estate) and declined by too much for the CRA to have been much of a factor. The Fed is by far the most important cause--it, not the CRA, caused sub-market mortgage rates and sub-market rates across the yield curve. The CRA could hardly have caused the boom and bust in the higher ends of the market.
The decline in underwriting standards was also caused more by the Fed than by any other institution.
Greenspan's lame self-defense--that sub-market rates at the low end of the curve couldn't have affected housing, overlooks interest rate arbitrage in a dynamic capital market. The Economist today points out that mortgage rates have declined lately along with bond yields. It cites the 10-year bond, hardly the short end of the curve.

> My understanding with the UK, and I've got Northern Rock
> in mind here, that a lot of mortgages were bundled into
> off-balance sheet SPVs.

To my knowledge that wasn't the case. Northern Rock had an SPV called Granite, the other mortgage lenders generally didn't AFAIK.

The big four commercial banks in Britain did get into trouble, but it wasn't through SPVs. There were two problems, they had deal for derivatives and CDS's that depended on US bank and they had more bad mortgage debt than they anticipated.

That's just AFAIK, I may be wrong, I haven't read about it for a while.

By the way, does anyone here know who the Chairman of Northern Rock was? It was Matt Ridley! that is Viscount Ridley. The guy who wrote "The Red Queen" and "The Origin of Virtue". He's currently doing a book tour of the US for his book "The Rational Optimist: How Prosperity Evolves". If any of you meet him then buttonhole him about banking. He knows all about Hayek and his ideas, hence the title of his book, Ask him about his experience of banking, please!

For those who blame CRA, please explain how CRA which mandated investing money from a community in housing within the community - that is the "R" - reinvesting - resulted in all the subprime mortgages in new housing tracts in Nevada or California. Were lots of people living in tents in those areas, making money they deposited in the local bank, thus triggering the requirement banks reinvest the deposits within the community?

The ability for a bank to get CRA credit for mortgages in an MBS it bought was done only in the past decade or so. Previously banks could meet CRA requirements by making a share of its loans to qualified buyers in traditionally redlined neighborhoods within the territory they had banks. Republicans extended CRA in this manner as a means to allow banks to escape the requirements of CRA in their mortgage origination. In other words, the point of CRA was undermined in a cynical promotion of predatory subprime lending to those traditionally discriminated against based on lack of education and financial sophistication.

"Fannie/Freddie and CRA are incestuously interwined, hard to let one off the hook without letting off the other. I don't think that Jaffee et al have done all their homework here since neither of them mention CRA-eligible MBS created via F&F."

But the ability for banks to get CRA credit without directly making loans, but instead being able to get the credit buy buying predatory loans that the bank was prohibited from making by regulators was a conservative policy move to undermine CRA and its goals.

Name one liberal advocate of fair housing who supported the policy that allowed unregulated mortgage origination the means for banks to avoid their required community reinvestment by buying securites.

View 1:
When we supplied arms to Afghanistan during the Russian invasion of that country, the Jihad was reborn. Jihadists made names for themselves, perfected the insurgency methods and pushed out a far superior fighting force. This inevitably led to 9/11.
View 2:
None of the actual 9/11 actors or weapons were involved in the Afghanistan invasion, therefore American training and American Armament of Afghanistan freedom fighters had absolutely not one thing to do with the occurrence of 9/11.

View 1:
CRA lowered the lending criteria for making home loans to many borrowers. Fannie Mae and Freddy Mac were instructed to buy up these sub-prime mortgages in order to protect the banks making these loans. The instructions for Fannie Mae and Freddy Mac were loose enough to allow non banks to also enjoy the no risk lowered standards lending business. This led to an absolutely huge number of low quality loans being made which led to the eventual collapse of the economy worldwide. Thus CRA is in fact very culpable in the financial crisis.
View 2:
Because the potentially bad loans were given to Fannie Mae and Freddy Mac, and we have reviewed the original lenders books and found no evidence of increased bad loans there, there is obviously no reason to worry about CRA as having been a contributor to the financial crisis.

Greg or others,
I have written an article (7 pages or so) on the Spanish housing bubble in which I deal with some of the issues I think most relevant that explain it. I haven't been able to publish it anywhere. So if you want to read the article, I can send it to you.

Canner and Bhutta: “The CRA does not cover non-bank lenders, such as mortgage and finance companies, so their active participation in subprime lending occurred without any CRA incentives.”

In practice, this turned out to be a distinction without a difference, because the Clinton Administration told the non-bank lenders that the CRA, with all its tedious paperwork, would be extended to them legislatively unless they started acting functionally as if they were already covered.

Angelo Mozilo of Countrywide flew to DC and signed a treaty in 1994 with HUD secretary Henry Cisneros pledging to make CRA-style pledges of lending to underserved minority and lower-income markets. For example, Mozillo announced a $600,000,000,000 CRA-style pledge by Countrywide at his Harvard lecture in February 2003. Then, in January 2005, he announced a $1,000,000,000,000 CRA-style pledge, with Countrywide Board Member Cisneros overseeing it.

This is not to say that Cisneros held a gun to Mozilo's head and forced him to lend insane amounts to people who didn't meet traditional credit standards. Instead, they both thought it was a great idea economically and morally. They both thought that waging war on racist redlining was going to make them a fortune. They were both drank the Diversity Kool-Aid and though it delicious.

Or take Washington Mutual, which was covered by the CRA, and had to pass CRA reviews to be allowed to make its 29 acquisitions over the last two decades. It pledged $375,000,000,000 in CRA loans to be allowed to buy Dime Bank in 20001. It won a CRA bidding war with regulators to be allowed to move into the disastrous SoCal market.

The government couldn't hold a gun to anybody's head and make them lend $375 billion. They could always quit. But the government could change the culture of mortgage lending by 40 years of selective favoritism toward executives like Kerry Killinger and Angelo Mozilo.

Why was WaMu, with its derisible strategy, able to buy out so many big lenders? To understand it, think about it the other way around: why didn't more prudent financial institutions outbid WaMu for acquisitions?

Say there are two banks, WaMu and Scrooge-Potter BanCorp. The latter is owned by Ebenezer Scrooge of Charles Dickens’ A Christmas Carol and Mister Potter of Frank Capra’s It’s a Wonderful Life. While WaMu is beloved for lending to anybody with a pulse, Scrooge-Potter BanCorp is widely loathed for taking a dim view of lending money to likely deadbeats.

They both would like to buy George Bailey’s Bailey Building and Loan Association. ACORN and the National Community Reinvestment Coalition announce they will protest vociferously against regulatory approval of the merger unless the winner pledges to make $50 billion in minority and low income loans.

Fearing a debacle of defaults, Scrooge-Potter BanCorp issues a two-word press release: “Bah, humbug”. And it drops out of the bidding.

WaMu announces: “Well, heck, we’ll promise to lend $55 billion.”

In fact, because Scrooge-Potter realized its quest was hopeless, WaMu got Bailey Building and Loan for less than it would have paid if the government wasn’t biased in favor of imprudent bankers. This gives WaMu more money to pursue more targets.

Consider the indirect effects on Scrooge-Potter BanCorp. Who would want to go to work for a bank that can’t make acquisitions because it won’t play nice with the government on CRA? Scrooge-Potter can’t buy anybody, it can only be bought. So, how’s your job security at Scrooge-Potter looking? Wouldn’t it make more sense to go work for WaMu instead?

The CRA drives the climate of opinion in the entire mortgage industry. If you wanted to be able to buy other banks, you had to play ball.

Practically everybody did.

Over time, the madness infects the entire culture of finance, as the government labels the prudent bankers automatic losers in the great game of acquisitions.

For a good review of how Democratic politicians' concern for minority homeownership worked in harmony with greedy lenders' drive to get rich, see Mother Jones' reporter Alyssa Katz's 2009 book "Our Lot."

But the single biggest political factor in mortgage meltdown was Republican President George W. Bush's October 15, 2002 White House Conference on Increasing Minority Homeownership, here he demanded from industry and regulators 5.5 million additional minority homeowners by 2010, and, crucially, castigated the traditional lending requirement of a having a downpayment as the leading impediment to racial equality.

Republicans don't like to talk about because it makes Bush look bad, and Democrats don't like to talk about this White House Conference on Increasing Minority Homeownership because it makes minorities look bad.

In California, where a sizable majority of the money was lost in the country on defaults, the % of first time homebuyers putting no money down soared from under 7% during the late Clinton years to 43% under Bush.

In 2006 in California according the federal Home Mortgage Disclosure Act database, minorities accounted for 77% of all subprime home purchase dollars borrowed, and 56% of all home purchase dollars borrowed. They had higher foreclosure rates than whites, as well:

A study by economists at the San Francisco Federal Reserve of 239,101 mortgages issued in California during the Housing Bubble reported:

“We also find that race has an independent effect on foreclosure even after controlling for borrower income and credit score. In particular, African American borrowers were 3.3 times as likely as white borrowers to be in foreclosure, whereas Latino and Asian borrowers were 2.5 and 1.6 times respectively more likely to be in foreclosure as white borrowers.” [ Lending in Low- and Moderate-Income Neighborhoods in California:The Performance of CRA Lending During the Subprime Meltdown,by Elizabeth Laderman and Carolina Reid, Federal Reserve Bank of San Francisco, November 26, 2008]

The spoiler is that high LTV mortgages are much more prevalent in UK than Germany. My hunch is that this is linked to pfandbrief law, and all of this contributed to Germany missing out on the housing bubble.

@Steve: I have argued in print about the importance of the various ways that federal housing policy pushed Fannie and Freddie and others into making bad loans, including the connection between Countrywide and their push to increase Hispanic homeownership. But thank you for demonstrating that this was NOT the CRA, but other policy initiatives.

Note my argument was not that federal housing policies designed to expand homeownership were not a problem, just that the impact of the CRA specifically was quite small.

I see what you mean. But the chart doesn't give any historical data. My understanding, and I may be wrong, is that quite high loan-to-value ratios have been the norm in Britain for more than a decade at least. What I means is, I don't think there has been any change major on the British side that could cause a bubble.

I think central bank activity has been more important. In my view all that regulations have done is to shape where the boom has occurred within the Eurozone.

"Note my argument was not that federal housing policies designed to expand homeownership were not a problem, just that the impact of the CRA specifically was quite small.

"You and Greg keep changing the subject."

My point is to finally explain the mortgage meltdown, not to rehash familiar partisan arguments. Republicans like to blame the Community Reinvestment Act because it's not their fault, and they like to ignore Bush's role in undermining traditional credit standards in the name of racial equality. Democrats like to define the role of diversity in the mortgage meltdown as narrowly as they can get away with, ignoring the Clinton department's use of the threat of extension of the CRA as a club to get non-banks, such as Mozilo's Countrywide, to lend like they were under the CRA. Both parties supported the Diversity Dogma that minorities were not getting enough mortgage money.

If you'll follow the links above, you'll find much to help you gain a more sophisticated understanding of this complicated and vastly misunderstood subject.

The problem wasn't CRA. The problem was the "affordable housing" push to increase home ownership as a national policy. CRA was a small PORTION of that much larger effort.

Bill Clinton came out with his National Housing Policy in 1995 and implemented it in 1996 along with new quotas on CRA. They created a new genre of loans to make it easier for people to get INTO homes: Alt-A, Option ARM, Subprime - all the "affordable" products that have caused us troubles.

Then, his HUD convinced Wall Street to mass-securitize these mortgages to add liquidity to the market. They pushed Fannie and Freddie to buy subprime loans (something they had refused to do) by offering affordable housing credits.

If you look at house prices, they began to appreciate faster than inflation PRECISELY when Clinton made his big housing push, raising home "ownership" rates by about 300 bps. In the early part of the decade, with this entire infrastructure in place, Greenspan lowered interest rates creating a search for yield. This made MBS wildly popular and increased demand for more mortgages to feed the MBS pools.

House prices soared, and ONLY the affordable products put those prices within reach of the average budget. If the neg-am or interest-only payment was within people's budgets, they were buying without caution about the ability to meet payments at the fully amortizing rate, sell, or refinance.

In mid-decade, Congress pushed the GSEs to "catch up" in market share with Countrywide, IndyMac, and mortgage securitizers. This force-fed liquidity into the system and led to more highly leveraged purchases.

Note that the mortgage interest deduction, low interest rates, affordable payments, no down payment, expectations of higher house prices, etc. DISTORTED the buy vs. rent decision. Furthermore, the availability of affordability products produced price competition among buyers who could not afford the fully amortizing payments. It also created externalities of expectations for future price appreciation which later became negative externalities from systemic risk.

Bottom line: without the "affordable" products, the housing bubble would have lost steam as house prices outpaced budgets for people with no down payment and fully amortizing payments. Bill Clinton created those products and it was in 1996 when house prices became unhinged from inflation, not during the Bush Administration.

But Bush deserves blame too for continuing the policy under his "ownership society."

None of that exonerates CRA. Ask any banker and they will tell you they made loans because of CRA that they would have otherwise turned down, not because of race but because of credit quality. During the boom, banks had already abandoned traditional models of lending and adopted "originate to distribute" because the GSEs were buying any piece of paper with MORTGAGE written at the top. What better way to meet your CRA obligations and avoid all the risks?

BTW, all the research to date in academia and from regulators AVOIDS discussion of CRA default rates. Instead, they compare profitability between CRA regulated institutions and non-CRA regulated institutions. This is sophistry. A bank forced to take on the risk of low credit individuals will raise fees, undertake investments with higher return and higher risk, cut overhead, and otherwise compensate for what they're forced to do. If these loans were truly profitable, you wouldn't need a law to make banks lend to minorities.

Not surprisingly, minorities suffered disproportionately from the crisis. They paid the highest interest rates, bought closer to peak prices, had the least stable jobs, and were among the first to default.

IO and Option ARMS don't reduce principal. The products don't help people become home "owners." They help them become home "living inners" with the option to sell at a profit or default. Who can blame them for buying the houses? And why are we surprised we had a bubble and crash?

Do you know how many programs and agencies of state and federal government are dedicated to the task of increasing home ownership?

Ed Leamer of UCLA demonstrated that housing IS the business cycle. We need to destroy the Housing Industrial Complex before it destroys us.

Let me add some info about how loans are classified in the data sources.

If a bank originates mostly subprime loans, then ALL of its loans are considered subprime. If they originate mostly prime loans, then ALL of its loans are considered prime. That's how the Mortgage Bankers Association collects the data.

So if a bank originates 51% prime and 49% subprime, then ALL of those loans are prime.

Furthermore, many people CHOSE subprime loans because of the affordability options that were available with them: no down payment, interest only, neg-am, etc. There were also affordability characteristics for prime loans as well.

So the numbers we see vastly understates the extent of subprime loans which were floated and which subsequently defaulted. That brings us to the "party line" now that Prime loans are the major source of default. That's only because the banks which compromised their standards the most and originated mostly subprime loans had ALL their loans categorized as such. Prime loans also constitute the largest volume of loans. It was only a matter of time before unemployment and systemic risk got to those loans too.

When GSEs were buying everything called a mortgage, prudential lending standards didn't matter anymore. Differentiating between prime, subprime, Alt-A, and loans from CRA-regulated institutions is like describing different colors and consistencies of human excrement.

The default rates and net impact of CRA has been lost in the data. You can't blame CRA for the crisis per se, but it was most definitely part of the larger scheme of inducing home ownership as a political objective, particularly for minorities.

How can you guys write all of this and ignore the money trail? Who made the money? Who benefitted? That leads you to the correct answers. Incentives matter. I find it difficult to believe that any adult would think that the bankers were conned into this, yet managed to make record profits and grow by leaps and bounds.

For non-experts, saying "CRA" is a label for saying "the scheme of inducing home ownership as a political objective, particularly for minorities."

The CRA is the tip of the iceberg that everyone can understand -- and in many ways it was the horse busting open barn door for other developments, as DP explains -- and it continued to be the point of the spear, in the drivers seat driving government and GSE policy.

You really have acknowledge any of these points, Steve:

How the CRa push drove GSE policy.

The fact that these econometric studies are bogus substitutes for direct full population field research with direct data rather than indirect "scientific" inferences via proxies.

How the CRA drove developments in securitization.

Well, let's start with three.
How the CRA degraded the lending culture.

Was there a high enough level of CRA-related lending to spark our current crisis? Not on its own, of course. The crucial link was the extension of CRA-type thinking and regulation to the secondary mortgage markets through the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, which buy loans from banks in order to provide liquidity. Beginning in 1992, the Department of Housing and Urban Development pushed Fannie and Freddie to buy loans based on criteria other than creditworthiness. These “affordable housing goals and subgoals”—authorized, ironically, by the Federal Housing Enterprises Financial Safety and Soundness Act—became more demanding over time and, by 2005, required that Fannie and Freddie strive to buy 45 percent of all loans from those of low and moderate income, including 32 percent from people in central cities and other underserved areas and 22 percent from “very low income families or families living in low-income neighborhoods.” As one former Fannie Mae official puts it: “Both HUD and many advocates in the early 2000s were anxious for the GSEs to extend credit to borrowers with blemished credit in ways that were responsible.”

How were such goals to be met? Crucially, subprime loans didn’t only allow banks to meet their CRA lending requirements; sold to Fannie and Freddie, they could also help the two secondary mortgage giants meet their affordable-housing targets. Not all subprime loans, or even a majority of them, were made for CRA-related reasons—the combination of cheap money and imprudent borrowers clearly made for a tremendous bubble. But such loans, bundled into asset-backed securities, were purchased (according to a June 2007 HUD report) especially by Freddie Mac to help fulfill its affordable-housing goals. As recently as April of this year, Fannie actually boasted about “mortgage products and options,” which included “reduced requirements for down payment and closing costs, choices for borrowers with less than perfect credit and flexibility to provide loans to home buyers with no traditional credit history.” In 2005 alone, Fannie Mae purchased some 3.8 million loans that could help them achieve affordable-housing targets. Bruce Marks might as well have been in charge of federal housing policy."

This whole “CRA caused the mortgage meltdown” thing is just another talking point used by Republicans to blame “liberals” for whatever mess happens to be in the news today. Do you know who came up with this gem of political spin? Thomas DiLorenzo, a confederate apologist who authored "The Real Lincoln: A New Look at Abraham Lincoln, His Agenda, and an Unnecessary War".

Anyway, it is all a waste of time. This lie has been swallowed whole by the right and that’s that.

But the CRA is old news. Haven’t you heard… environmentalists are to blame for the gulf oil spill.

Of course, as a HR Pro you know where it REALLY gets interesting, if you decide to walk the employee out on the same day you receive the notice - the decision on whether to pay them for the two weeks notice you are waiving. My experience suggests this is primarily a cultural call, and if you want the majority of your employees to work a notice when they resign, you don't want to withhold the notice pay.